# Howard University Comparison

Comparison of Techniques for Hedging Receivables.

Assume that Carbondale Co. expects to receive S\$500,000 in one year. The existing spot rate of the Singapore dollar is \$.60. The one‑year forward rate of the Singapore dollar is \$.62. Carbondale created a probability distribution for the future spot rate in one year as follows:

Future Spot Rate Probability

\$.58 20%

.63 50

.67 30

Assume that one‑year put options on Singapore dollars are available, with an exercise price of \$.63 and a premium of \$.04 per unit. One‑year call options on Singapore dollars are available with an exercise price of \$.60 and a premium of \$.03 per unit. Assume the following money market rates:

U.S. Singapore

Deposit rate 7% 4%

Borrowing rate 8 5

Given this information, determine whether a forward hedge, money market hedge, or a currency options hedge would be most appropriate. Then compare the most appropriate hedge to an unhedged strategy, and decide whether Carbondale should hedge its receivables position.

Forward hedge

Money market hedge

Option hedge

 Possible Spot Rate Option Premium per Unit Exercise Yes or No? Amount Received per Unit (also accounting for premium) Total Amount Received for S\$500,000 Probability

Unhedged Strategy

 Possible Spot Rate Total Amount Received for S\$500,000 Probability
1. Assume that Baton Rouge, Inc. expects to need S\$1 million in one year. Using any relevant information in part (a) of this question, determine whether a forward hedge, a money market hedge, or a currency options hedge would be most appropriate. Then, compare the most appropriate hedge to an unhedged strategy, and decide whether Baton Rouge should hedge its payables position.

Forward hedge

Money market hedge

Option hedge

Amount Paid Total

Option per Unit Amount

Possible Premium Exercise (including Paid for

Spot Rate per Unit Option? the premium) S\$1,000,000 Probability

Unhedged Strategy

Possible Total

Spot Rate Amount Paid Probability

Question 2

a -Compare and contrast the various exchange hedging strategies. Create a table for the comparison. Ensure to give the advantages and disadvantages of each strategy.

b. Explain how a forward contract can backfire. Illustrate using numbers not used in the text or covered in class.

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